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Question 3 Parker & Stone, Inc., is considering a new project that requires an initial fixed...
Question 3
Parker & Stone, Inc., is considering a new project that requires an initial fixed asset investment of 1.2 million. The project also requires an initial investment in net working capital of $250,000. The project is expected to generate $950,000 in sales and cost $400,000 every year for three years. The fixed asset follows a straight-line depreciation. After three years, the fixed asset has a zero book value but is estimated to have a market value of $200,000, and the net working capital will fully recovery. The corporate tax rate is 35%.
- What are the operating cash flows in each year?
- What are the cash flows from net working capital and the net capital spending in year 3?
- What are the CFFA in each year?
- If the required return is 10% for a similar risk level of project, should the company implement this project?
Solutions
Expert Solution
Following are the calculations:
| SL no. | Particulars | Remark | 0 | 1 | 2 | 3 |
| 1.00 | Sales | Given | $ 9,50,000.00 | $ 9,50,000.00 | $ 9,50,000.00 | |
| 2.00 | Cost | Given | $ 4,00,000.00 | $ 4,00,000.00 | $ 4,00,000.00 | |
| 3.00 | EBITDA | Sales-Cost | $ 5,50,000.00 | $ 5,50,000.00 | $ 5,50,000.00 | |
| 4.00 | Depreciation | 1.2million/3 | $ 4,00,000.00 | $ 4,00,000.00 | $ 4,00,000.00 | |
| EBT | EBITDA-Depreciation | $ 1,50,000.00 | $ 1,50,000.00 | $ 1,50,000.00 | ||
| 5.00 | Tax | 35% x EBT | $ 52,500.00 | $ 52,500.00 | $ 52,500.00 | |
| 6.00 | EAT | EBT-Tax | $ 97,500.00 | $ 97,500.00 | $ 97,500.00 | |
| 7.00 | Depreciation | Added back as non cash | $ 4,00,000.00 | $ 4,00,000.00 | $ 4,00,000.00 | |
| 8.00 | OCF | EAT+Depreciation | $ 4,97,500.00 | $ 4,97,500.00 | $ 4,97,500.00 | |
| 9.00 | FCINV | Given | $ -12,00,000.00 | |||
| 10.00 | WCINV | Given | $ -2,50,000.00 | $ 2,50,000.00 | ||
| 11.00 | Salvage value | Given | $ 2,00,000.00 | |||
| 12.00 | Tax on profit from sale | 0.35 x (Salvage value - book value) | $ -70,000.00 | |||
| 13.00 | FCF | OCF+FCINV+WCINV+Salvage+Profit | $ -14,50,000.00 | $ 4,97,500.00 | $ 4,97,500.00 | $ 8,77,500.00 |
| 14.00 | Discount factor Formula | at 10 % | 1/(1+0.1)^0 | 1/(1+0.1)^1 | 1/(1+0.1)^2 | 1/(1+0.1)^3 |
| 15.00 | Discount factor | Calculated using above formula | 1 | 0.909090909 | 0.826446281 | 0.751314801 |
| 16.00 | DCF | FCF x Discount Factor | $ -14,50,000.00 | $ 4,52,272.73 | $ 4,11,157.02 | $ 6,59,278.74 |
| 17.00 | NPV = sum of all DCF | $ 72,708.49 |
- OCF are given at Sl. no .8
- In year 3 the CF from WCINV and salvage value = 250000+20000-70000 = 380000
- CFFA are calcilated at SL. No. 13
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